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Sometime after Benchmark Assisted Living, one of the largest senior-care providers in the Northeast, entered talks to acquire Village Retirement in December 2004, negotiations hit a snag. Village Retirement's management was extremely reluctant to allow Benchmark executives to contact key employees. "We knew that was a problem," says Jill Haselman, Benchmark's senior vice president for organizational development. "But I don't think we pushed hard enough."

The Wellesley, Massachusetts-based company pursued the merger anyway and decided to keep seven out of nine of the executive directors of the Village Retirement facilities it purchased without interviewing them first. That turned out to be a mistake. Less than a year after the deal closed, four of those directors had left the company, forcing Benchmark into the costly and time-consuming task of recruiting replacements. As employees who didn't fit the new corporate culture began to exit, Benchmark faced the costs of unemployment, severance packages, recruiting, and temporary labor. "We're still cleaning up, because we didn't get in and clean house the first time," Haselman says.

It's a common merger mistake. Companies routinely overlook human-capital issues during deal negotiations or during the early stages of integration. "It always surprises me how rarely CFOs participate in human-capital decisions," says Ross Zimmerman, a senior consultant with human-resources consulting firm Hewitt Associates LLC. Mistakes such as failing to retain key managers, putting the wrong workers in important jobs, neglecting to equalize pay and benefits, or missing human-capital liabilities can torpedo a merger and turn synergy projections into an expensive joke.

Part of the problem is that many HR departments aren't even prepared to assist in the due diligence that a merger requires. A 2005 study by professional-services firm Towers Perrin, headquartered in Stamford, Connecticut, found that just 26 percent of the companies surveyed considered their HR departments to be "fully ready" to aid a merger or an acquisition effort.

Not only do companies overlook human-capital concerns, but they also fail to account for them in the deal price, says Robert F. Bruner, dean of the University of Virginia's Darden School of Business, who studies the reasons why mergers fail. "The cost of an acquisition isn't just the amount paid to the target's shareholders," he says. The true total must account for all the human-capital issues that get larded in, says Bruner. That includes, for example, severance payments, consulting fees, and perks — such as the continued use of the corporate jet or the company condo in Paris — paid to the CEO of the target company.

Before signing a deal, the acquirer should create an integration plan, says Marco Boschetti, a Towers Perrin consultant. Then, the acquirer should quantify the costs of the plan, budget for those costs, and tie them back into the deal price. Severance payments, raises, new hiring, relocations — all need to be reflected in the pricing model. "HR should have a seat at the table only if they are able to talk dollars and cents," says Boschetti.

Retaining Talent

When a deal goes badly, says the University of Virginia's Bruner, the best talent leaves first. "They either get poached or they get frustrated and quit," he says. The costs of addressing human-capital issues will be inconsequential if the deal hits the skids and the new company discovers that it really needed to have those people around.

And nothing can precipitate an exodus of talent like the collision of disparate corporate cultures. So when Sprint Corp. and Nextel Communications Inc. signed a deal to merge last year, a team of top executives sat down together before any attempt was made to bring the two companies together and set about crafting a new corporate culture for the combined firm.

"I think it was clear to us, having seen what other companies have done, that we had to get a good sense of the heritage and strengths of both companies and then leverage the best of each," says Sprint CFO Paul Saleh. "But at the same time, we wanted to establish the traits we wanted to emphasize in the combined entity and what behaviors we wanted our leaders to exhibit, such as a strong focus on customer services, teamwork, integrity, delivery of results, and respect for one another."

The dual goals required a fairly deliberate process. With the input of colleagues from both firms, as well as James Kissinger, the designated head of HR for the merged company, top executives selected their own direct reports but did so with an eye toward creating the culture they had envisioned in their early meetings. "With those things in mind, we then tried to select executives from both companies who would best exemplify these characteristics and best represent that new culture."

A common merger mistake is that companies are too slow to put the key people in place, which can create a lot of uncertainty. High anxiety, says Saleh, hurts productivity and can cause important personnel to leave. So after it identified top managers, Sprint moved quickly to announce its decisions. "That approach is probably not intuitive," says Saleh. "People often argue that if you move too early on this, you run the risk of losing talent. But in fact, the quicker you move, the better you are in creating clarity around certain functional leads and responsibilities."

In any deal, the ability to retain the right people is "the most important factor of all," says Robert K. Shearer, CFO of Greensboro, North Carolina–based apparel firm VF Corp. Shearer has been involved in more than a dozen acquisitions in his 20 years with the company. One of the very first things VF does is to meet with a target's managers, including those who are outside the senior-executive suite. "It can be difficult," says Shearer. "The seller may be trying to get a feel for our level of interest and will not want to open up the company, and particularly its people, until it is sure we're serious."

When VF acquired Vans in 2004 and Reef in 2005, it ensured that it could retain nearly all of the top-level executives before it signed each deal. The company was interested primarily in the growth potential of each target, so Shearer believed that keeping high performers was essential to assuring that growth. "This is the same team that has built the brand," he says. "If we don't believe that we can retain the individuals who really live and breathe it, who know it inside and out, that may kill the deal."

VF has walked away from deals when it felt it couldn't retain top talent. In some cases VF didn't feel confident that, for instance, a company founder whose personal style or skills were important to the development of the brand would be content to operate in a subordinate role for any length of time. Rather than risk gaining a new unit but losing its driving force, says Shearer, VF has elected to not do the deal at all.

The CFO has also learned that one key to retaining the best executive talent is to allow for a certain amount of flexibility in their management styles, rather than trying to cram every acquisition into a VF template. "In my career, I have changed the way I think about these things," he says. "We don't have all the answers, and there are other ways of doing things. A little give-and-take can go a long way."

That approach varies somewhat from other cases, such as Sprint, where a cohesive corporate culture was ironed out in the early stages of the merger. In general, it appears that firms that are merging in order to jointly offer a single product — such as mobile phone service or assisted living — find it desirable to fuse cultures as quickly as possible. In the case of VF, however, the success of individual subsidiaries is often dependent on the image they project, so creating a seamless corporate culture across brands as diverse as adventure-gear supplier The North Face and lingerie manufacturer Lily of France may not be advantageous at all.

There is, of course, a flip side to keeping the right people: How do you identify those who aren't a good fit for the combined firm? Some experts say that doing this is a priority. "The most critical financially related strategy is to figure out who not to hire from the company you are purchasing," says Benchmark's Haselman. "This is something we have learned to do better, after having failed miserably at it and seen it cost us 5 to 20 times as much as it should."

Benchmark has found that in deals where no attention is paid to the suitability of inherited employees, unexpected costs start cropping up. "We have learned the hard way — and I mean the million-dollar hard way — to look at the cultural fit and performance level of frontline staff, because there is never another time in the history of the company when you can choose your own workforce," says Haselman.

Uncovering Liabilities

As Benchmark learned when it acquired Village Retirement, it's critical for the CFO and the merger team to interview key talent during the due-diligence phase of a merger and secure input from the HR department. Haselman says the cost of turnover following an acquisition is exponential. "When human resources or organizational development doesn't work with finance in the due-diligence phase, it costs you more money," she says.

And it's not only because of the cost to replace individuals that don't fit the new organization. Haselman says a certain percentage of employees of the target company will almost certainly be sufficiently upset by the change to file lawsuits. Personnel interviews are the best way to uncover legal risks, although in some cases, wrongful-termination lawsuits will be inevitable. "I would advise any CFO doing an acquisition to factor in a very hefty human-resources legal budget, because the lawsuits start going wild," Haselman says.

Other risks related to human capital include underrecognized or unrecognized liabilities. Towers Perrin's Boschetti says hidden pension liabilities can be detrimental to a merger. They are especially common in transactions involving overseas entities. "In some countries, it's easier to play games, or their liabilities are less transparent," he says. For this reason, acquirers should get an outside appraisal of a target's pension-plan status.

Accrued vacation can be another surprising liability. When companies merge, they will usually have to adopt a uniform vacation and sick-day policy. That can be expensive if the merger target has a very generous policy or if it has been allowing workers to accrue lots of vacation time over the years. Meanwhile, risks such as discrimination or sexual-harassment liabilities are harder to see. "You can ask some questions that might uncover it, but if you can't get to it, you can't get to it," says Boschetti.

Matching Salaries

One of the most difficult challenges in any business combination is rationalizing salary and benefits packages across the new company. "If [the target's] average pay is half of the buyer's average pay, guess what — their payroll is going up 50 percent," says Boschetti. "All those things need to be allowed for within the projection model in which you value the business, which is all a function of the CFO."

When pay inequity isn't dealt with, it can only cause problems. The integration process in the acquisition of US Airways by America West Airlines, for example, has been acrimonious and expensive, according to Bruner, because of difficulties in merging highly compensated US Airways pilots with their lower-paid counterparts from America West. "In the absence of any kind of harmonization or equalization of compensation among pilots on either side, how will the company ever achieve the operational flexibility it needs?" asks Bruner.

Even in cases where the firm being acquired will remain operationally independent of the buyer, pay and benefits should be put on a level playing field, warns Elizabeth Phillips, head of HR services at Bostonian Group, a benefits consulting firm. "On the operational independence model," she says, "one of the things the finance executive has to consider is the benefits packages of both firms. Because while they may be independent, if the firm you are looking at has inferior or superior benefits, it will cause problems."

Those costs then need to be calculated and used in the pricing model. Unfortunately, not all CFOs do this well, says Bob Bundy, worldwide partner at Mercer Human Resource Consulting and head of the firm's Americas M&A business. One of the most common problems he sees is a failure to project out pro forma labor costs several years past the closing date. Particularly in mergers in which there is no significant reduction in workforce, he says, labor costs will grow "at a progression that's greater than that at which both organizations alone would have grown." The reason: if one firm's salary structure is higher or its benefit structure is more generous, the tendency will be to pick "the best of both worlds." The quickest way to lose buy-in from employees is to cut their salary or benefits based on the deal, says Bundy. "Rarely have I seen anybody lower pay packages or lower benefits," he says.

When CFOs do have the foresight to make such projections, he says, "they are always surprised at the size of the numbers." During negotiations of a recent joint venture between two medical centers, Bundy says, the finance team took his advice and created several years' worth of pro forma projections of future salary growth. The numbers were so surprising, he recalls, that the entire deal had to be repriced.

Acquirers should keep in mind, too, that combinations — especially with underperforming targets — can put a drain on human-capital resources. That was the experience at Benchmark, says Haselman. In one of the firm's recent deals, she says, the company gave managers of successful properties the responsibility for bringing newly acquired units up to Benchmark's standards. But six months after the integration, it was clear that the practice of moving top managers had hurt both occupancy levels and expense controls at their original facilities. "In hindsight, I wish we had forecast the replacement cost of moving talented managers out of successful properties," says Haselman.

It's an important lesson. If a merger is to be counted as a success, says Hewitt's Zimmerman, CFOs must realize that, in terms of productivity, they effectively begin the process with a deficit, and they will need a clear strategy as to how to make up for that before they expect any gains.

Gone are the days when the CEO of an acquiring company could talk blithely of billion-dollar "synergies" in advance of a deal and trust that no one would mention the subject again once the heavy lifting began. These days, merged companies are held to their synergy forecasts, and the task of upholding those promises usually falls to the CFO.

Uncovering human-capital issues and planning for them down the line will go a long way toward meeting those goals.